Friday, 26 April 2013

Why predicting stock markets from Google Trends could be bad news for science.

A new study from Tobias Preis at the Warwick Busines School appears to show that Google Trends data can predict falls in stock prices. The theory is that investors search for information about stocks they are thinking about divesting before doing so. While I've been sceptical about some uses of Google Trends data in the past (see here and here for details), the latest study has a solid theoretical mechanism and strong data analysis to support it.

So why am I unhappy to see this study?Well, the publication of this article guarantees one thing about the future. There will be bots using Google Trends as part of their trading strategy. And if people are using this trading strategy, then there is an incentive for others to manipulate the Google Trends data to try and exploit this strategy. The number of searches required to shift Google Trends is reasonably high but not at all out of the question for someone with access to a botnet (and there are a lot of people with access to botnets). We could even see a new high frequency trading style battle between different trading and searching algorithms each trying to fool the other about their intentions.Now, people will probably argue that the botnet response will remove the profit in the Google Trends trading strategy. This may be true, but the reported 326% over 7 years return suggests significant room for reducing the signal of Google Trends before it becomes unprofitable to trade off it. However, even if Google Trends still returns sufficient information that it can be used as part of a trading strategy, the results may have devestating externalities for other users of Google Trends data. While there has been a great deal of hyperbole around Google Trends, there have been successful uses of it for measuring different variables from flu outbreaks, to economic trends, to issue attention. The usefulness for these applications may be casualties in the race to make Google data only marginally profitable for trading. So I'm happy to see new uses of these data but I worry that a profit incentive may ultimately make them entirely worthless. Here's hoping to be wrong.